Stabilizing housing should make toxic assets easier to sell

When the subprime lending market fell off a cliff and the housing market with it, trying to figure out what the mortgage loans and bonds were truly worth became a pointless exercise since no one could agree when home prices would stop falling. Banks didn’t want to sell the assets at a steep loss since they hoped (and prayed) in the long run many of these loans and bonds would continue to perform. Buyers, of course, wanted to be compensated handsomely for the risk of taking on these loans when prices continued to plummet and the ranks of jobless swelled.

That appears to be changing. Though the unemployment rate is expected to go higher still and will stay elevated for some time to come, the number of those getting pink slips has started to moderate and home prices appear to have stabilized. Check out the chart below of the S&P Case-Shiller index of home prices in 20 metropolitan areas.

Enter the PPIP program. The FDIC announced yesterday that Residential Credit Solutions beat out 11 other bidders in its pilot program to unload what are now called legacy loans and once called toxic assets. It’s not a bad deal considering RCS only had to plop down $64 million in cash for 50% stake in a portfolio of $1.3 billion of home loans, with leverage and a FDIC guaranteed loan taking care of the rest. And it’s far easier now to asses the risk in these assets than say a few months ago.

If this works out to the FDIC’s satisfaction, the agency will use it as a way for public/private funds under the PPIP program to buy loans off banks that are still up and running. There’s still the question about whether banks will want to sell, but it will be much harder for them to argue that a loan is worth say 80 cents on the dollar, when models based on more stable inputs suggest otherwise.